The way in which Islamic banks (the “Banks”) foreclose on properties they finance due to a default of the customer depends on whether the Banks either: a) register the properties in the names of their customers and mortgage them in favour of the Banks, or b) register the properties under the names of the Banks.
In the first scenario, the Banks often sell the properties through an auction pursuant to Law No.14 of 2008 (Clauses 25 and 26) concerning mortgage of properties in Dubai. The process set out by the law is that if a Customer defaults on payment of their debt secured by the mortgage, the Bank will give the customer notarized notice to pay the debt within a maximum period of 30 days. Should the Customer fail to meet this obligation, the Bank may consequently file an application with an execution judge in order to sell the property directly via. an auction. Moreover, the benefit of this process is that the Bank does not need to institute proceedings before the three levels of courts, that is, the Court of First Instance, the Court of Appeal and the Court of Cassation (or Supreme Federal Court as the case may be) in order to sell the property which, at the same time, saves time and money for the Banks in terms of court costs and legal fees.
When this concept first started, the Banks were successful in selling the properties by auction because the auction was conducted in the presence of buyers who always bid for best prices available. However, that being said, these auctions were also being conducted online which meant that buyers would also offer low prices for these properties which were insufficient to settle the debt owed by the Customers to the Banks. This sometimes meant that Banks were stuck with unsold properties.
It should be noted that the principle for the sale of properties by auction is also recognized by Law No. 3 of 2015 (Clause 53), concerning Regulations of the Real Estate sector, in Abu Dhabi as well. From this, we can conclude that the Banks may only sell properties through an auction in Dubai and Abu Dhabi specifically.
Concerning the second scenario, where the Banks register properties in their own names, the title deeds show the owners of the property are the Banks themselves, but it is subject to the terms and conditions of the lease agreement between the Banks (as lessors) and the Customers (as lessees). In this scenario, the Banks cannot apply the aforementioned laws listed above, and they are required to bring proceedings against the Customers in default and ask the court(s) to de-register the lease from the title deeds, permit the Bank to retake possession of the properties and to then claim their compensation – this value would be the difference between the outstanding amount due by the Customer and the market price of the properties. However, this process clearly takes time and causes the Banks to incur court costs and legal fees. That being said, the advantageous aspect of this scenario means that the Banks may sell the properties at ease and through their approved brokers so that they may obtain higher prices, compared to an auction, and therefore settle the debts owed to them.
The Banks, of course, face challenges themselves during the course of the litigation process, the most notable being that most of the Islamic modes of finance are not defined and/or codified by the UAE Law with the exceptions of salam (forward sale) and mudaraba (joint ventures). The adversaries in these matters argue that these modes of finance are null and void. One example that demonstrates this is of a case based in Abu Dhabi brought by an Islamic bank against its Customer for breach of musharaka (partnership) where the Customer’s lawyer argued that the musharaka was void because it was not incorporated in one of the forms of the companies set out in the commercial companies law. Another example took place in Dubai, where the Courts recategorized ijara muntahya bitamleuk (lease with ownership of property passes to customer) as a sale and not a lease and treated the fixed amount paid by the Customer as an instalment of the purchase price of the property and not fixed rent.
We are aware of cases where Dubai Courts have obligated Islamic Banks to pay the service charges imposed on them for the use of common facilities such as swimming pools and gardens because the Courts regarded the Bank as the owner of the subject property pursuant to Law No. 27 of 2007 (Article 22) concerning Jointly Owned Properties in Dubai. However, this grievance has been addressed by the newly issued Law No. 63 of 2019 (Article 29) concerning Jointly Owned Properties in Dubai which states that the owner of the property is liable for the service charges unless it is agreed otherwise between the contractual parties. The Article goes on to allow the Banks to state in their lease agreements that the lessee (the Customer) will be liable for the service charges and not the Bank.
Interestingly, two recent and important developments in legislation have occurred of late, which may help the Banks bridge the legislation gap. The first legislation would be Federal Law No. (8) of 2018, concerning Financial Leases, which matches to a great extent the ijara agreements being used by the Banks and reflects the terms and conditions approved by their respective Sharia Committees, with the exception of a few provisions such as the requirement to register lease agreements (which the Banks do not often do anyway).
The second legislation comes from the Central Bank of the UAE who issued a Resolution of the Higher Sharia Authority of the Central Bank which instructed the Shari’a Committees of the Banks to adopt and implement Shari’a standards set out by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). The AAOIFI is a non-profitable organization which is taken with standardizing Shari’a principles of Islamic modes of finance to ensure that no differences in the interpretation of Shari’a occurs amongst the Shari’a Committees of the Banks and consequently the Islamic products and agreements are consistent and harmonious.
We have arrived on the opinion that the AAOIFI standards now form part of the UAE Law, which the courts may consider during litigation if raised by the Banks since the Banks are now obliged to be bound by the Resolutions of the Central Bank pursuant to the Central Bank Law.
Be that as it may, these standards are still fairly new which means that they have not yet been tested, and it, therefore, remains to be seen how the courts will interpret them in the coming future.